Will President-elect Donald Trump’s plan to implement tariffs cause stocks to fall? This is what history tells us.

In less than four weeks, President-elect Donald Trump will be sworn in as the 47th president and becoming the second US leader ever to serve non-consecutive terms. However, Wall Street decided to start the party a little early.

Since election day, the iconic Dow Jones Industrial Average (DJINDEXES: ^DJI)referent S&P 500 (SNPINDEX: ^GSPC)and depending on the growth stock Nasdaq Composite (NASDAQINDEX: ^IXIC) all have risen to record highs. This is a continuation of the robust gains that major Wall Street indexes enjoyed during Trump’s first term. Between January 20, 2017 and January 20, 2021, the Dow Jones, S&P 500, and Nasdaq Composite rose 57%, 70%, and 142%, respectively.

But to quote Wall Street’s favorite admonition: “Past performance is no guarantee of future results.”

While stocks thrived with Trump in the Oval Office, there is genuine concern that his desire to implement tariffs on day one could undermine American companies and send the stock market tumbling. From what history tells us, this is not out of the realm of possibility.

Donald Trump making remarks while standing behind the presidential podium. — Former President and President-elect Donald Trump delivers remarks. Image source: Official White House photo by Andrea Hanks.

Last month, President-elect Trump unveiled his plan to impose a 25% tariff on imports from its immediate neighbors Canada and Mexico, as well as a 35% tariff on goods imported from China, the second-largest economy worldwide

The overall purpose of tariffs is to make American-made products more price competitive than those brought in from outside our borders. They are also designed to encourage multinational companies to manufacture their products destined for the US within the confines of our borders.

But according to an analysis by Liberty Street Economics, which publishes research for the Federal Reserve Bank of New York, Trump’s tariffs have previously had a decisive negative impact on U.S. stocks exposed to countries targeted by those tariffs.

The four authors of Do import tariffs protect US businesses? distinguish between the impacts of tariffs on outputs and inputs. An exit fee is an added cost on top of the final price of a good, such as a car imported into the country. Meanwhile, an input tariff would affect the cost of production of a final good (eg higher costs of imported steel). The authors note that higher entry tariffs make it difficult for US manufacturers to compete on price with foreign firms.

The authors also examined the stock market returns of all US publicly traded companies on the day Trump announced the tariffs in 2018 and 2019. They found a clear negative change in stock prices on the days that the tariffs were announced, with this effect most pronounced on companies that were exposed to China.

In addition, the authors observed a correlation between firms that performed poorly on rate announcement days and “future actual performance.” Specifically, these companies experienced declines in profits, employment, sales and labor productivity from 2019 to 2021, according to the authors’ calculations.

In other words, history would suggest that the tariffs being implemented on the first day of Donald Trump’s second term may be a catalyst to the downside for the Dow. S&P 500and Nasdaq Composite.

Unfortunately, the story has a bit of a double whammy for investors. While comparing historical stock performance on tariff announcement days during Trump’s first term provides a limited data set, one of Wall Street’s leading valuation indicators, which can be tested back over 153 years, offers many reasons for concern.

Many investors are probably familiar with the price-to-earnings (P/E) ratio, which divides a publicly traded company’s share price by its trailing 12-month earnings per share (EPS). The traditional P/E ratio is a fairly effective valuation tool that helps investors determine whether a stock is cheap or expensive, relative to its peers and broad market indices.

The downside of the P/E ratio is that it can be easily disrupted by shock events. For example, the lockdowns that occurred during the early stages of the COVID-19 pandemic made trailing 12-month EPS relatively useless for most companies for about a year.

This is where the Shiller P/E ratio of the S&P 500, which is also known as the cyclically adjusted P/E ratio (CAPE Ratio), can come in handy.

S&P 500 Shiller CAPE Ratio Chart — S&P 500 Shiller CAPE Ratio data for YCharts.

The Shiller P/E ratio is based on the average inflation-adjusted EPS of the previous 10 years. Looking at a decade of inflation-adjusted earnings data, impact events are a moot point when assessing the stock’s valuation as a whole.

As of the closing bell on Dec. 20, the S&P 500’s Shiller P/E stood at 37.68, which is more than double its 153-year average of 17.19. But what’s more concerning is how the stock market has responded after previous instances of the Shiller’s P/E exceeding 30.

Since January 1871, there have been only six times when the S&P 500’s Shiller P/E hit 30 during a bull market rally, including this one. Each previous event was followed by a 20% to 89% decline in the S&P 500, Dow Jones Industrial Average and/or Nasdaq Composite.

To be clear, Shiller’s P/E gives us no clue as to when stock market declines will begin. Sometimes stocks have extended valuations for several weeks before falling, such as the two-month stretch before the start of the Great Depression in 1929. Meanwhile, Shiller’s P/E exceeded 30 for four years before the dot com bubble burst. . However, this historical valuation metric suggests that stocks can fall, and it wouldn’t have made a difference which presidential candidate won in November.

A smiling person holding a financial newspaper while looking out a window. — Image source: Getty Images.

However, history can also be a beacon of hope and inspiration, depending on your investment horizon.

As much as investors would prefer to write off stock market corrections, bear markets and declines are ultimately a normal and inevitable part of the investment cycle. But what is important to note is that the ups and downs associated with investing are not linear.

For example, analysts at Bespoke Investment Group calculated the average calendar day length of bull and bear markets in the S&P 500 since the start of the Great Depression and discovered night-and-day differences between the two.

For one thing, the S&P 500’s 27 bear markets between September 1929 and June 2023 averaged just 286 calendar days (about 9.5 months), with the longest bear market at 630 days natural On the other side of the coin, the typical S&P 500 bull market lasted 1,011 calendar days over the 94 years examined. Also, 14 of the 27 bull markets (if you include and extrapolate the current bull market to today) have stayed longer than the longest bear market.

^ SPX chart — ^SPX data for YCharts. YCharts S&P 500 return data starts in 1950.

An analysis by Crestmont Research looked even further back at stock performance over long periods and came to an even more encouraging conclusion.

Crestmont calculated the 20-year total returns (including dividends) of the S&P 500 since the beginning of the 20th century. Although the S&P didn’t officially exist until 1923, researchers were able to track the performance of its constituents in other indexes to satisfy their back test back to 1900. This 20-year holding timeline produced 105 periods ends (from 1919 to 2023).

What Crestmont’s annually updated data set shows is that all 105 20-year periods would have produced a positive total return. Hypothetically speaking, if you had bought an S&P 500 index fund just before the start of the Great Depression in 1929, or before Black Monday in 1987, and held that holding for 20 years, you would still have made money.

The Crestmont Research dataset also shows conclusively that the stock market can make patient investors rich regardless of which political party is in power. No matter how you arrange the pieces of the political puzzle, 20-year total returns have always been decisively positive.

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Will President-elect Donald Trump’s plan to implement tariffs cause stocks to fall? This is what history tells us. was originally published by The Motley Fool

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